It fought the challenges that most banks are facing including margin compression and falling stock prices. But it also faced an inordinate amount of turnover as other banks cherry-picked Heritage's lenders and executives, stole market share and outpriced the bank for some loans and deposits.

But if the numbers don't show it now, Heritage has been taking strides to ensure its future growth and its leaders say the bank is heading in the right direction.

Its most recent earnings report shows net income declined at Heritage Commerce Corp., the bank's holding company, by $1.1 million in the third quarter compared to the same period a year ago. Year-to-date, net income is down $1.6 million.

Heritage was trading near its 52-week low at press time just under $17 and down from a peak of $27.34.

The bank's purchase of Diablo Valley Bank in June, recruiting several new high-level bankers and a new strategy to keep Small Business Administration loans on the books can be blamed for the drop, says CEO Walt Kaczmarek.

The strategy also knocked the bank's efficiency ratio -- which measures earnings vs. expenses and overhead -- up to the 68.2 percent year-to-date from 58 percent for the first nine months of 2006. The lower the number, the more efficient a bank is considered.

But a lot of those are one-time costs associated with hiring and the retention of SBA loans.

Because of the subprime lending crisis, the secondary market for all loans has seized up. There are fewer buyers willing to purchase even business loans and the price for the loans on the secondary market has fallen.

Heritage decided it can make more money in the long run in interest on the loans than it could get in fee income selling them in the short term, Kaczmarek says.

"I'd hope in 2008 we'd have our efficiency ratio back to more normal ratios, between 55 and 60," says Kaczmarek, who was brought in 2005 to get the bank back on track and to grow it.

The bank's growth strategy centers around its three locations in the East Bay, two of which were acquired in the purchase of Diablo Valley Bank in June of this year. The acquisition added more than $1 billion in deposits, boosting the combined entity's deposits 26 percent.

But at $65 million, some analysts have said the bank might have paid too much for the three-year-old, two-branch bank.

"We clearly paid a high premium for Diablo Valley Bank," Kaczmarek says. "We felt it was very important for the long-term strategy of the bank to have a strong East Bay presence. And right now we feel very happy about the acquisition."

Despite the hit to income, the bank's growth plan is just what analysts want to see, says analyst Fred Cannon of Keefe Bruyette & Woods.

"The best thing they have going is they have got the profit picture turned around," Cannon says. "They're a high-performing, quite profitable institution. And they seem to be starting to gain some traction in terms of growth."

The bank was started in 1994 and built a strong reputation in community business lending under four different brand names. The structure became inefficient as the bank grew, with too much bureaucracy, says its founding chairman. Heritage collapsed its four charters into one national charter under its holding company in 2003, Heritage Commerce Corp.

But the bank was still inefficient, its leaders say. Its efficiency ratio hovered in the mid 70s and earnings were not meeting shareholder expectations.

The bank removed the four presidents of the former individually chartered banks. And in 2004, when Smith resigned, founding chairman Bill Del Biaggio, Jr., took over as interim CEO for a year and began to restructure the bank.

"What it really boils down to is, from the time we had started, we'd been on a path of trying to grow the institution rather quickly and hadn't paid enough attention to our shareholder value," Del Biaggio Jr. says of that period for the bank. "Our earnings were not growing like they should have been as we grew."

Kaczmarek was courted from Comerica Bank to improve the bank's earnings and figure out how to grow it. Both the board of directors and Kaczmarek are credited with a clear vision and efficient strategy that has helped put the high-performing bank back on course.

"Since Walt has been here, we're continuing to grow but also have been cost effective without having any impact on levels of service," Del Biaggio says.

The San Jose-based business bank has suffered several years of turnover as high ranking executives left to start banks of their own or work for those bank founders.

"We lost market share because we had quite a bit of turnover in the last two years in the bank," Kaczmarek says. "When I came on board in March of '05, the bank had numerous holes in its business side of the bank in lending, on both the management and lending sides. It took us about one and a half years to fill those openings."

Heritage owns just more than 1 percent of the market share in Silicon Valley, which made it the 14th largest bank in the region and the second-largest locally headquartered bank at $1.3 billion in assets.

But it has lost market share in Santa Clara County to Bridge Bank run by former Heritage executives and other outsider banks moving into Silicon Valley. And San Jose's newest bank, Focus Bank, is run by Richard Conniff, a former Heritage chief operating officer and regional president who has recruited other Heritage alumni.

Heritage and other local banks say they've benefited from Wells Fargo's purchase of Greater Bay Bancorp because they've been able to recruit the bank's employees. Greater Bay's banks made up the sixth-largest bank in the region and owned more than 5 percent of the market share.

Heritage picked up Roxann Burns former president of Greater Bay SBA lending and she's courted several other SBA lenders to follow her. The Bank also hired Gerriann Smith to head its Walnut Creek office, a critical branch in Heritage's long-term growth plan. And it hired Janice Yano-Miyatake from Santa Clara Valley National, also owned by Greater Bay Bancorp.

"In my view Heritage is a company benefiting from the turnover in the banking industry and suffering from it," says Cannon. "I think right now they are starting to come out net ahead."

Heritage has also implemented new ways to keep shareholders happy, starting a dividend program in 2006 and, this year, announcing it would buy back $30 million worth of the bank's own shares -- or about 11 percent of its total shares at the current price over the next two years. It also raised its dividend 33 percent to 8 cents per share on Nov. 2.

"In general our shareholders are positive on the tactics we've taken," Kaczmarek says. "I'd have to say none of them are happy with where the bank stock price has gone today."

While Heritage says it doesn't have direct exposure to the subprime crisis since it didn't make any subprime loans, executives say it made a conscious decision to stay conservative in its commercial lending.

Heritage has strong credit quality and its leaders believe 2008 will be a year that will showcase the bank's strategy.

"We want to see it continue to grow," says Del Biaggio. "We want to be bigger and better and we're headed that way."